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"Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice" - Adam Smith

23 Things We're Telling You About Capitalism XIX

Written by Tim Worstall | Monday 03 June 2013

Our nineteenth thing is that of course planning's lovely: so much so that the collapse of communism isn't to be taken all that seriously., Yes, OK, so the central planning of the entire economy isn't all that good an idea (although Chang, almost ludicrously, believes that it did work in the early days. Someone should point out to him that the 5 year plans reduced economic growth from the NEP days: to say nothing about losing 8 million Ukrainian peasants by happenstance along the way.) but still there's a place for the very clever people in government to direct what everyone else thinks about making, buying and selling.

And even if that isn't true firms plan their activities, we've got lots of firms, so we must have lots of planning: and indeed we do have lots of planning.

The problem with this is that he's mixing and matching in a way that isn't really viable. Firms do indeed plan: but their plans are then subject to examination through competition with the plans of all the other firms. You know, that marketplace thing. Planning is thus preparatory to the test of whether the planning has worked. With government planning we don't then get that test: for governments don't then subject, or at least limit as much as they can, the exposure of their plans to said market. You can see this quite clearly in the current arguments about renewables and fracking for shale gas. The DECC has its plan, we'll all shiver in the gloom of solar powered (in England!) lights so therefore no one must be allowed to drill for shale which would upset that plan. Yes, I know they've said that it will be allowed to go ahead: but have you looked at the limits they've put on earthquakes? 0.5 on the Richter Scale was the last I saw: that's about the shock of the cat jumping off the bookcase next door*. A deliberate attempt to stifle an innovation that would ruin the government's plans. This is something that private sector companies don't get to do: which is why the results from private sector planning work out so much better. Someone else can indeed derail them, to the consumers' benefit, by having a different and better plan.

If you like, the market is where plans compete to see which is the best one. Government planning doesn't enter that competition so we never do find out quite how bad those government plans are. We just end up not quite as rich as we thought we were going to be or should be.

Chang also talks about how governments plan a lot of the R&D these days: or at least pay for it and thus presumably have some sort of plan about what they're going to spend it on. He also notes that the Soviets were pretty good at invention of spiffy things but this didn't seem to feed though into making said consumers any better off. He should read his William Baumol to see the connection between these points.

Baumol defines invention as the, well, invention of new and spiffy things. He makes the point that the Soviets did do satellites first. Indeed, either sort of system, planned or market, seems to be about the same at invention as the other. However, innovation is the getting of interesting things stemming from those inventions into the hands of consumers in a shape and form they desire. Either to do things with or to develop further to do other things with. And there the planned system is appalling and only market economies have ever really proven to be any good at all at it. The Soviets could make tanks alright but hot water tanks were beyond them (quite literally, the Soviet housing system didn't have them).

Which is really very much the same point as the one above. Markets provide the test to see what an invention might be used for, who is going to innovate with it. Further, given that we're talking also about capitalism here, that part of the system provides the incentive to risk the money to find out about one or other innovation. Which is why innovation is indeed driven forward on capitalist and market based societies and not in planned ones. OK, so governments pay for a lot of the R&D. So what? That's not the important part of the system: innovation is, not invention.

Which brings me back to hot water tanks. The Soviet system operated on district hot water heating plants. Hot water piped into the radiators and bathrooms of the whole urban area. From a planning point of view is looked quite efficient: but as it turned out it's not what the consumer actually wanted. As soon as the old system fell one of the most popular additions to a Russian apartment was an individual hot water system: the type of tank that the Soviets, the planners, didn't even know was wanted rather than the ones they knew how to build but which the market sniffed out almost immediately it was allowed to.

And that, in the end, is why planning is inferior to markets. Because planning will provide what the planners think the people want, or should want, or even what the planners think they should have. Markets allow the consumer to do the demanding of what they do want.



*Hyperbole alert. Update: I have now been told that it's actually 3,000 cats jumping off a 2 metre bookcase. No, really, it is, assuming perfectly inelastic cats. And it's also happening half a mile away.....

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23 Things We're Telling You About Capitalism XV

Written by Tim Worstall | Tuesday 28 May 2013

In our fifteenth thing that we didn't know about capitalism (because the capitalists have been so misinforming us) we get rather flipped over into the absurd. Chang's claim is that we all get browbeaten into believing that poor countries are poor because the people there are not entrepreneurial. He does on to point out, quite rightly, that this is an absurd thing to believe. The poor everywhere are vastly more entrepreneurial than us bourgeois middle class types: they have to be in order to survive. This is as true of poor people in rich countries as it is in poor too. The ducking and diving that goes on to make a life on benefits more pleasant is entrepreneurialism in a raw form. All of which is why no one at all does go around claiming that the poverty of some countries is based upon a lack of that raw entrepreneurialism making that claim something of a strawman.

Chang is also quite right in pointing out that the reason why this greater extent of entrepreneurialism amongst the poverty stricken doesn't then go on to create great wealth is not because of some deficiency in the people themselves. Nor in their ability to do that ducking and diving. The lack is in the institutions in that society that allow the microbusiness to flower into the larger one. This is indeed quite true.

We also know quite a lot about what it is that is lacking in those institutions. Chang mentions things like crooked bureaucrats: the short hand for not having them and their ever changing interpretations of the regulations (and the subsequent opportunities for personal enrichment to turn a blind eye) is the rule of law. There are other things too: Hernando de Soto has pointed out that many of the poor in these poor nations do indeed own property. But they don't own it legally: they hold it informally, by common recognition that they do rather than government recognition of their ownership. This means they cannot borrow against it, mortgage it, leverage their wealth. This can also be known as the absence of property rights. Or at least the absence of the formal recognition, de jure, of de facto property rights. De Soto has gone on to show that when such rights are formally acknowledged then matters improve.

In the absence of such property rights it's extraordinarily difficult to have a smoothly functioning financial system. The reason microcredit ever worked at all (and Chang is again perfectly correct in pointing out that it's not been quite the success sometimes advertised) was because it replaced that security of the lender being able to call on property for repayment with the security of the social pressure of the guarantors of the loan. Borrowers were in groups: the others in the group could not borrow until the first loan had been paid off. It was the finding of a different form of security, in a society without those formal property rights, that allowed any success at all. But clearly, if we want a financial system that can be used for the financing of the aquisition of property (whether it be a bullock for ploughing, a building to trade from or live in or a factory) then there has to be a system of recognising and transferring the ownership of that property. Backed up by a functioning court system and so on.

So far it looks like I'm agreeing with Chang in this chapter. And I'm not disputing his facts, this is true. But let us recall what the book is about as a whole. The way in which we have been mislead into believing that capitalism and free markets have created the wealth that we enjoy. The application of capitalism and markets to the currently poor being what would make them rich: this is the thesis that Chang wishes to refute. But his facts in this chapter simply show us quite how important and true that thesis is.

For what Chang's actually complaining about, what he's stating is keeping the poor poor, despite their admirable entrepreneurialism, is the absence of capitalism and free markets. For that's what capitalism is: a method of describing who owns productive assets. Markets are a method of exchanging things one with another, under the rule of law. It is the very absence of these things that Chang is identifying as keeping them poor: which is exactly the same as the capitalist and market case for why people are poor. They've not got the institutions that allow entrepreneurialism to flourish. They have, in short, too litle of that law, capitalism and market freedom necessary to get rich.

All of which is why this chapter leads into such absurdity. Chang tells us that the poor don't have this, that and t'other which is what keeps them poor. Yes indeed: but this, that and t'other are what capitalism and free markets are. At its most basic too: the rights to own, transfer and trade legally.

In a sense I am agreeing with Chang. I agree entirely that what blunts the success of that admirable effort and nous shown by the poor is the absence of the institutions that allow it to flourish. But Chang seems to think that this shows that capitalism and markets are not the way forward: when the very definition of the institutions that allows such effort to flourish is capitalism and markets. So how the analysis, that the poor are kept poor by the absence of capitalist institutions, can be used as an example of why capitalist institutions are undesirable for the poor I'm not quite sure. But that is the absurdity that Chang is putting forward.

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23 Things We're Telling You About Capitalism XVI

Written by Tim Worstall | Wednesday 29 May 2013

Our sixtetenth thing is that we're all just too damn stupid to be allowed out without the government nanny holding our hands. Chang doesn't put it in quite these words but but it is his general meaning. He runs through the usual arguments: we free marketeers think that people are rational so allow them to get on with it. Chang says (rightly) that people aren't always rational so they need guidance. When that runs into the problem that the people doing the governing are going to be just as irrational as everyone else Chang then says well, OK, government should simply ban things until we understand them. For example, and it's his example, new financial products should be banned until we understand them.

One major problem with this approach is that the argument for market activity doesn't depend upon rationality. One is, over and above that, that I know my desires better than you know mine. And however much I want to be Prime Minister I don't know yours better than you do. There's thus an extremely strong assumption that I shouldn't be (even if I do become PM) trying to restrict your actions unless there is some over riding reason to do so. What I think best for you ain't good enough. That over rising reason can be found in Mill for example: the proximity of an about to be broken nose to your swinging fist. Chang's argument in favour of regulation doesn't overcome this reason for non-regulation at all.

It's also rather irritating to be told, again, "that as Adam Smith said about the invisible hand". No, he didn't: he used the phrase once in WoN, about the propensity for domestic investment even in the face of the free movement of capital. It was absolutely nothing at all about the glories of market coordination. Grr.

The real heart of Chang's argument is Herbert Simon's point that we humans have bounded rationality. We cannot consider everything so we don't: we're not bright enough to consider the ins and outs of every possible action so we have rules of thumb which we act by. This is undoubtedly true: it's rather the flip side of the idea that we don't particularly maximise utility but we do satisfact (although a purist would argue that by not bothering to think too much, because thinking is hard, we are maximising utility). And there is indeed a great deal of truth in this. Company routines, our own sleep patterns and breakfasts (to use Chang's examples) are based not on rigorous contemplation of all the avaliable options. Rather, on the very limited number of choices that we allow ourselves through our routines or company structures.

Thus, says Chang, the government should impose such regulation on all: and that's the leap that is too far. Yes, even in the face of the uncertainty (no, not risk, uncertainty) about the impact of that new financial instrument.

Think a moment of evolution. We all generally think of it as leading to a certain harmony. Which isn't, as deeper down we know, how it actually is. We've this random mixture going on through mutation, we've a further mixture of genes through mating (in sexual animals at least) and it's the ever changing environment which does the selecting about who and which will survive. That's the only way that life can in fact deal with the inherent uncertainty about future conditions.

You can see where I'm going with this: market processes are an endless repetition of experimentation, much like those gene mutations and mixtures. Which of these experiments will survive depends upon the environment they are tried in. Writing great smartphone apps in 1955 would not have been a path to success: in 2015 it's highly likely to be. And this is exactly why we don't want government building regulation to stop the experimentation. Precisely and exactly because we don't know what the future environment will be and thus don't know what will succeed in it. And because it's uncertainty, not risk, we cannot know: therefore we must not stop the experimentation.

Another way of putting this is that we don't want to regulate market experimentation out of existence because such market actions are precisely the way we find out what is either good or bad. Further, if we don't allow the ideas out into the markets we can never get enough information to know whether they are good or bad: so, in Chang's universe nothing would ever happen because we've lost the very mechanism by which government can decide whether to regulate or allow something.

The final killer for Chang's extreme interpretation of the precautionary principle (for that is what it is) can be explained by anyone who has ever tried to explain something to a politican. You know, the people Chang wants to make all these decisions for the rest of us. They're no brighter than you or me and almost inevitably less well informed. They also have rather different motivations: one becomes a politician with power by spending inordinate amounts of time working out how to gain and hold on to power. Bad incentives, less information and no greater (at best) mental faculty than the rest of us: their rationality is more bounded than our own. This is not a good argument in favour of their being responsible for protecting us from our own bounded rationality.

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23 Things We're Telling You About Capitalism XVII

Written by Tim Worstall | Thursday 30 May 2013

In Thing 17 Chang tells us that the current preoccupation with extending access to higher education is grossly wrong. It might well be true that more people should enjoy three years at the gleaming spires (and in the modern world, the booze, babes or boys to choice) and we are indeed in a richer world so why not? We do expect to take some portion of our ever increasing wealth in more leisure and there's no reason at all why this shouldn't be three years at the start of working life rather than more days off during it or more years of senescence after it. But if we think that more of this higher education is going to make us all richer then we're simply wrong. In this argument Chang is absolutely and completely correct.

Even the blind Haplorrhini gets a banana sometimes.

As Chang points out, Tony Blair might have caught the zeitgeist with his mantra of "education, education, education", but there's absolutely no evidence at all to show that he was right. Countries with higher further education rates do not have richer economies, ones growing more strongly, ones with higher technologies. There just isn't, in the actual data, any correlation at all with wealth and university education. Indeed, there's the suggestion that going above the 10-15% of da youf going off to uni is wasteful: we just end up in a signalling game rather than actually teaching anyone anything that's useful in terms of working life.That 10-15% that Switzerland had until recently and we had historically.

Given that so very little of what we're ever actually taught at university is ever used in a job (other than teaching the next cohort through uni) this shouldn't come as all that much of a surprise.

We might also muse on the fact that Chang's book has been very popular among the Guardianista classes. Haven't seen any of them mentioning this point though. Funny that.

I would take issue with only one of his points.

"What really matters in the determination of national prosperity is not the educational levels of individuals but the nation's ability to organise individuals into enterprises with high productivity".

I would replace national and nation there with economics and economy. For the nation state isn't actually the determinant of that ability to organise into such enterprises with high productivity. Indeed, one of the major points we can make about the UK is that absolutely it isn't.

London, The City at least, is organised into a global economy that connects Hong Kong, Singapore, New York and a number of other lesser international legal, financial and banking centres. London is also the richest of the EU statistical units (ie, not nation states, next level down). Cornwall, parts of the North, the bin ends of Wales and Scotland, are some of the poorest such regions in the EU. It is the ability of an economy to organise high productivity, not the ability of a nation to do so, which is important.

Perhaps you might think this a trivial distinction. But if we keep on getting all national about these things then we'll become both nationalist and statist. Which is very much the point we shouldn't be taking from this. If such high productivity can be organised across national boundaries, without national governments doing the planning or the regulating, then we know that the creation of those high productivity enterprises is not dependent upon the nation or the State, don't we? Nor even that "helping hand" of government.


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23 Things We're Telling You About Capitalism XVIII

Written by Anonymous | Friday 31 May 2013

Chang's eighteenth is the regulation can sometimes be good for business, even if business doesn't think so, therefore we should not rail against the regulation of business. This is certainly true to some extent: regulations against trading while insolvent are most certainly helpful to clearing out the deadwood of zombie enterprises from the economy, to the benefit of all other businesses. But that isn't of course, quite what Chang means. His meaning rather is that a benevolent government will stop business doing things that might be extremely worthwhile in the short term but will have bad long term effects. An example of his is that companies in poor countries should be barred from importing old technologies. As this could lock them into a sub-optimal development path, perhaps they should be forced into importing more expensive, more up to date, technology even at that short term cost.

This is an argument to which there are a number of answers. The first and most obvious being, well, what evidence do we have that any random group of bureaucrats or politicians are capable of recognising a technology, let alone an appropriate one? This isn't a skill that is notable in the currently advanced economies after all: vide any and all governmental computing projects. We'll not dwell too long on the way in which in currently poor countries what is an appropriate technology, or supplier of, tends to be influenced by how fine the new car of the licensing bureaucrat's mistress is either. Nor who paid for it. And a third objection would of course be what the hell's it got to do with the government what technology a private company installs?

But this is Chang's point of course: that it is indeed the government's business whether I use (in my current project) wet or dry gravitational separation and that there is indeed a bureaucrat or politician somewhere who knows the answer. I think not: and no doubt I am near blasphemous given that my basic project is to recreate a process that the Socialist Government of this country I'm in closed down in 1952.

What Chang's insistence is missing though is that we've only actually got one process that reveals to us whether a technology is appropriate or not: that's its interaction with the rest of the world through the free market. As before, we are uncertain about the future. We simply do not know what future conditions are going to be. The only method we have of dealing with that uncertainty is to try lots of things and see what does survive in the conditions that happen. Which really does mean that we cannot centrally plan what we do, detail which technologies who should use from the Ministeriums, simply because that will not allow enough variety.

There's a possibility of redemption in this comment of Chang's:

The story of GM teaches us some salutary lessons about the potential conflicts between corporate and national interests - what is good for a company, how important it may be, may not be good for the country.

This is most certainly true: but Chang then manages to get it entirely the wrong way around. Leave aside the now ritual complaint that we shouldn't be talking about the country, or the nation, but the economy, which is a very different thing. Chang avers that government planning and co-management of those large firms like GM will help them to survive in the long term. Which is entirely true, large firms can indeed co-manage government to aid in ensuring the survival of them. The way they do this is by manipulating the desire of the politicians and the bureaucrats to regulate. The burden of regulation is much easier for a large firm to carry than the same burden is for the small and snappy competitor chasing at its heels. Regulation thus becomes a wall keeping out that free market competition which is the gale behind capitalism's creative destruction.

And that's really what is wrong with the idea of extensive regulation of industry. That it is actually bad for the economy in and of itself as it protects the corporate dinosaurs who can manipulate it at the expense of new competitors and the consumers.

Another way of putting this: even if all of those who implemented regulation were the omniscient philosopher kings that Chang assumes inhabit our ministries (rather than the bumblers who do), regulation is still bad for the economy as a whole over time. For regulation protects the incumbents. And the important thing we know about this capitalist and market system is that advances come not from incumbents developing but from their being replaced. It is market entrance and exit that drives the system, not the development of the current market players. Thus a system of regulation such as Chang proposes, one that protects the incumbents at the expense of the newcomers is going to be bad for the economy in the longer term. Even, dare I say it, for the nation.

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23 Things We're Telling You About Capitalism XX

Written by Tim Worstall | Tuesday 04 June 2013

For our twentieth outing we're told that equality of opportunity isn't enough: we must also have a deliberate and planned levelling of outcome in order to produce a truly just society. Chang manages to reach this position by confusing inequality with insufficiency: something not unknown over there to the left of us. But I'm afraid that this is an incorrect conclusion for the two things really are very different indeed.

Fortunately Chang is agreeable to the idea that entirely equal rewards for very different efforts doesn't actually work. There has to be, unlike Maoist China, some connection between the work put in and the relative rewards taken out. Which is true: but that's not quite right even there. For the truth is that we shouldn't really be caring at all about the efforts that is being put in. We are not Puritans, we do not think that work for its own sake is good. Indeed, I myself am very much an Anti-Puritan in this sense. I care not a tittle nor a jot how much work someone puts in to make their money: they're going to get some of mine according to the value that they produce for me. And that's also how it should be on the macro scale, in the entire economy. If, just as an example, Eddie Izzard finds it takes mere moments to think up a joke which has millions laughing for hours then good luck to him. It's not the effort put in that matters, it's the value he's created that does. Ditto with, say, the miner digging up tantalum to make our mobile phones. None of us gives a hoot whether it takes him 30 seconds or ten hours: the value is in the capacitors in the phones and that's what we're paying for.

That rewards should be commensurate with effort is a corollary of the fallacious labour theory of value. Rather than Adam Smith's much more correct theory of the value in consumption. With this correction we can move on. Now that we accept that it is the value produced for consumption by others which should determine income and reward, not the effort put into that production.

Where Chang does go wrong is in his insistence that true equality of opportunity isn't enough. He uses the example of a poor black child in South Africa: the schools are terrible, the teachers barely literate, in what sense can we say that he has equality of opportunity with his witer and richer fellow countrymen? He doesn't, of course. equality of opportunity would mean at least comparably good schools. Chang then compares this to the UK say, where a poor child won't have perhaps the same self-confidence as his richer contemporaries. Nor the same luxuries in his home life. All of which might well be true. Then comes the sleight of hand: this inequality of opportunity requires that parental incomes thus be equalised in some manner. Which is, I have to admit, an interesting use of the "it's all for the children" argument.

But it's an incorrect argument: equality of opportunity does not require equal incomes: it requires sufficient incomes. Sufficient to be clothed, fed, housed, warm and so on: sure, it needs all of those. But making sure that everyone has a sufficient income for their children to be provided with these necessary things is very different from insisting that incomes must be more equal. It might be a valid argument for some redistribution even, to ensure those sufficient incomes, but not for more equality of incomes as a specific goal. Imagine, just as a made up number, that it requires £5,000 a year to provide a child with a sufficiency of these things. If all children have that amount available for their care then we do have equality of opportunity in this education and life success sense: that other children have £40,000 a year lavished upon them does increase inequality but does not cause a reduction in opportunity.

That slide from having to reduce inequality to provide equality of opportunity just doesn't work I'm afraid. And given that we want reward to be tied to the value produced for others to consume, the evident and obvious truth that some do, with varying levels of effort, produce very much more value than others means that we're just entirely happy with inequality of reward: as long as we do have that equality of opportunity.


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23 Things We're Telling You About Capitalism XXI

Written by Tim Worstall | Wednesday 05 June 2013

The 21 st thing is that a larger government actually makes economies more flexible: thus we should have larger governments in order to increase the necessary flexibility of the economy. And if the first part were true then the second part might indeed follow: only it isn't, at least not in the sense that Chang means it.

As part of his argument there's one thing that Chang does which is really very naughty indeed. He compares the growth rates of various European countries to that of the US. And he divides the growth rates into two periods: early 1950s to late 70s, late 70s to now (or what was now when he wrote a couple of years ago). He's right that the European economies, with their larger state sectors, grew more quickly than the US did in the earlier period. Hence the claim that larger government can mean more economic growth. Except, well, there's just one thing missing from this calculation: the Wermacht. As the perceptive will have noticed the German Army did have something of a European tour in the years immediately preceeding the early 50s. And the destruction of getting them to go home again was considerable: something which did not happen to the US at the time.

Just as we expect a developing country to have a higher growth rate than a developed one, given that copying is easier than being at the technological cutting edge, so we also expect an economy recovering from a total war being fought on its territory to grow faster than one which is not. So while the growth rates are true we cannot use them as proof that larger governments will create more economic growth.

The real problem with Chang's position though is that he confuses two entirely different things. He talks about employment inflexibility: the way in which it's difficult to get fired and thus the workers all feel secure. He also talks about the existence of a decent welfare state: unemployment pay, health care, retraining opportunities and so on. The problem is that he sees these as being equal: both increase the security felt by the workers and thus increase their flexibility. Which is untrue: they work in very different ways indeed.

It is true that a decent welfare state does lead to greater flexibility in the economy. The workers (and everyone else in fact) will be less stuck in their ways if they know that a change in the economy does not mean destitution. But job security works entirely the other way around: those who are too secure in their jobs won't accept any change at all. Thus reducing the necessary flexibility of the economy.

The reason that this becomes important is because Chang points to the Nordics as evidence of his assertion that you can still have decent economic growth with a large government sector: indeed that it increases growth to have a large such sector. But the very success of the Nordics argues against all of the other strictures about free markets and capitalism that he wants us to understand and adopt. For it is true that they do have large and generous welfare benefits: the unemployment pay, the retraining and so on. They also have decent economic growth. But what they don't have is the sort of regulation, planning and government intervention into the economy that Chang proposes. Look behind the tax numbers (necessary to pay for those benefits) in the economic freedom index and look instead at everything else. They have less regulation of markets than we do, greater economic freedom than even the US, less intervention into capitalism than just about anyone other than Hong Kong. Which is what makes the places work of course: as Scott Sumner is fond of pointing out, Denmark might well be the most classically liberal economy on the planet underneath that welfare state.

All of which I admit I find rather amusing. It is true that the Nordics are nice places to live, despite those crippling tax rates (almost all of which are tumbling down). It is indeed true that they've had very decent economic growth over the years and decades. It's entirely true that they have a lavish social insurance system. But those economies work precisely because they ignore, do absolutely the opposite of, everything else that Chang proposes a government should do to an economy. They're more free market and capitalist than even the US: which is why they work. Indeed, it's probably true to say that the only way in which you can have a social safety net like they have is if you allow capitalism and markets to let rip: how else can you possibly afford to pay for it all?


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23 Things We're Telling You About Capitalism XXII

Written by Tim Worstall | Thursday 06 June 2013

Our twenty second thing is the rather alarming suggestion that finance must be made deliberately less efficient. This is a very odd indeed thing for an economist to say for our first assumption, right at the very start of the subject, is that the needs and desires of human beings are larger than the ability to assuage them. Thus increased efficiency is always desirable as it means we can assuage more desires with our limited stock of resources. Indeed, we usually go on to say that something that is in infinite, as compared to demand or desire for it, supply is not actually an economic good. So deliberately calling for less efficiency, no, not as a side effect of something else but as an aim in itself, is almost a form of anti-economics.

The claim is that finance now moves more swiftly than the "real" economy. Thus we must slow it down otherwise finance will be, erm, moving too quickly for said real economy. There's no evidence proffered for this assertion: it is simply asserted. People can buy and sell shares quickly which means that the money to build factories, something that takes some time, isn't around seems to be one lunge at a back up. Which is a very strange argument indeed as we don't seem to have any shortage of factories. Nor of investment to build them if someone comes up with a good idea. Indeed, the world seems to be awash with VC funds, with FDI, with bond funds looking for a good home for their cash. Far from finance not funding that "real" economy it's amazingly easy to get cash to follow an idea through, easier than it has ever been I would wager. And there are plenty of people, Nobel Laureates among them, who insist that the recent troubles were all about a global savings glut.

There is one shortage, this is true. Banks (especially UK ones) being unwilling to lend into companies. But this complaint is really just a disguised misunderstanding. Banks simply aren't the appropriate place to get risk capital from: public markets or private investors are. And as I say, there's no shortage of that sort of funding at all. SMEs aren't all that fond of it, true, because gaining such finance means giving up equity. Which is as it should be of course: you want risk capital you've got to share the upside as well as the downside.

Other than that there simply isn't a shortage of capital for companies: so the basic complaint seems invalid. Maybe finance is running faster than the real economy. Finance has certainly screwed up memorably in recent years as well. But if that real economy does still get funded, as well as all the froth that's being complained about, then we can't use the real economy not being funded as an excuse to do anything. And it should be noted too that a lot of the froth is actually the sharing of risk from those real world investments. The wheat futures market spreads the risks the farmer and the baker are taking: meaning that more funding can be offered as risk has indeed been spread. This continues out to even the most exotic markets. Sterling interest rate futures, as one example, mean that both borrowers and lenders can shift the risks of interest rate changes to speculators. Thus meaning that for the same amount of risk carried by lenders and borrowers there can be more lending done. The froth doesn't detract from that real economy funding: it adds to the ability to increase the volume of it in reality.

And I must say that I was most amused by one piece of evidence called in by Chang. He notes that the profitability of the finance sector has risen in recent decades. He uses this as the basis of a claim that obviously it should be pruned back. But profit, excess profit, as Adam Smith pointed out in not quite these words, is proof that you are adding value. So if profitability of finance has risen then that must mean that finance is adding more value. And the idea that we want to stop people doing that is again almost anti-economics.

I suspect that the real basis of Chang's complaints about finance is that his attitude towards it is akin to a Victoiran dowager's about "trade". We know that it goes on, is even necessary, but we most certainly wouldn't want anyone we know to be associated with it.

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23 Things We're Telling You About Capitalism XXIII

Written by Tim Worstall | Friday 07 June 2013

Chang's twenty third thing is that we really don't need to have lots of bright economists around in order to be able to run a decent economy. This is most certainly true provided that the economy is still run along the right basic lines: which might be the bit that we and Chang disagree about.

It's certainly true that all the time markets, nothing but markets, doesn't quite work. There are a number of imperfections that mean that we cannot just leave everything to voluntary action. We might point to natural monopolies as an example: someone, somewhere, has to stop them rooking everyone. We do like the rule of law which means we've got to have government (sorry anarchists) and the taxes to pay for it (sorry everyone). And there are more subtle problems out there: take externalities for example. By definition these are things that are not included in market prices and therefore are not considered in market transactions. We really cannot therefore conclude that markets will deal with externalities when hte whole point is that markets ignore externalities.

So we're all fine with the idea that we cannot have an entirely and wholly pure market system. Nor would we want one that is entirely capitalist: I'm extremely happy about the idea that the Army is a State run organisation. We tried private capitalism in this field and the Wars of the Roses just don't have that good a reputation. Not from the peon and churl end of the telescope at least and I know darn well that's where I would have been.

However, that doesn't mean that because we cannot be purist about these things that therefore any old intervention into the economy is just fine. Which is what Chang is partly doing. Having shown that some intervention is demonstrably desirable he then goes on to conclude that the sort of intervention he desires has been demonstrated: which the past 22 little notes might have dissuaded you of.

But I will agree that he's right: we don't need vaslty intelligent and highly educated economists running the place for us all to get gloriously rich. As Adam Smith himself said:

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice.

You'll note there's nothing there about managing the exchange rate, regulating the bendiness of bananas nor even one word about the employment of economists.

So of what use actually is economics. If we don't need economists to run the country then what point in the entire intellectual exercise? As Ben Bernanke has observed:

Having taken a stab at sociology and political science, let me wrap up economics while I'm at it. Economics is a highly sophisticated field of thought that is superb at explaining to policymakers precisely why the choices they made in the past were wrong. About the future, not so much. However, careful economic analysis does have one important benefit, which is that it can help kill ideas that are completely logically inconsistent or wildly at variance with the data. This insight covers at least 90 percent of proposed economic policies.

If I am to be fair about economics there's very little in the corpus of knowledge that makes up the field that is really about making the world a better place. Plenty of attempts at such of course, and many more from people who wouldn't know an econ if it came and micced them. What there is a great deal of is warnings about don't do this because you'll make the world worse. As PJ O'Rourke put it about the Soviet Union, shooting all the smart people and then killing off anyone trying to get rich does not great societal wealth make. We've got lots and lots of knowledge about things like that that we shouldn't be doing. There are some areas where things have to be done: those natural monopolies, externalities and so on. But they're few and far between when you think of the vast possibilities of human behaviour.

The real point of economics is to struggle manfully with those very few things which must be done, shoot down in flames at least 90% of the things that are suggested we should do and then leave the rest of it, the vast majority of life, to people to do as they wish as long as they're not harming others or their right to do the same. You know, the liberal idea of free people interacting voluntarily in a free market. Capitalism's just an offshoot of the rights to private property: and one of the lessons of the experiment that was the 20th century is that we do have the data about what happens when you try to do that.

So, capitalism and free markets for all it is then. Which, given that the last 30 years, as the two have spread through globalisation, has seen the largest reduction in absolute poverty in the history of our entire species, is very probably a damn good idea. After all, even if we don't need many economists or much economics to do it, the poor getting rich is what we all want, isn't it?

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235 years of the Wealth of Nations

Written by Dr Eamonn Butler | Wednesday 09 March 2011

Today is the 235th anniversary of the publication of The Wealth of Nations by Adam Smith. For a quarter of the last millennium, we have actually known the principles by which wealth is created and maximised. The trouble is, that for most of the same time, we have been trying to resist that information, thinking that we can somehow do better than the market.

The Wealth of Nations is a great book: most objective commentators would probably put it among the top five books ever written, in terms of its influence on humankind and the way we live. Yes, it's very eighteenth-century stuff, sprawling and wordy, with enormous digressions on things that do not seem very interesting to us today. And yet it is the book which took economics out of its primitive phase and made it distinctly modern. We can understand what Smith says because it is all around us today.

The very first sentence of the book dismisses the old idea that the wealth of a nation was the amount of gold and silver that it had hoarded up in its vaults. Rather, says Smith, the measure of a country's wealth is what it produces. He had invented the idea of gross national product. And the wealth of the citizens of that country depends on how many there are. He had invented the idea of GDP per capita. And so it goes on.

But surely his greatest breakthrough was the realisation that we do not have to grow or make things in order to increase our wealth. We can also increase it by simply exchanging things. If you have something I want and I have something you want, we are both better off by swapping it. And that is the foundation of market exchange and trade, and of the specialisation that makes our production and exchange system so spectacularly efficient, creating and spreading benefit throughout the world.

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